FOREX Trading and Investment An Interactive Qualifying Project Report Submitted to the Faculty of WORCESTER POLYTECHNIC INSTITUTE In partial fulfillment of the requirements for the Degree of Bachelor of Science By Mariela Qirici Sebastian Franco Jonathan Baiden Craig Nesbitt Approved by: Prof. Hossein Hakim November 11, 2013 Abstract This Interactive Qualifying Project serves as an introduction to the world of Foreign Exchange trading by giving a basic guideline as to how one can get started with FOREX trading and the development of a trading strategy. It concentrates on designing a Trading Strategy that if profitable, can be turned into a company. The project includes the design of a computer program (indicator) that facilitates market analysis for more efficient decision making. In addition it includes an explanation of the indicator coding process as well as the group methodology for trading which was tested under individual Demo accounts, providing promising results for a profitable trading strategy using the indicator created. ii Table of Contents Abstract ......................................................................................................................................................... ii Table of Contents ......................................................................................................................................... iii Table of Figures ............................................................................................................................................ vi Chapter 1 : Introduction ............................................................................................................................... 1 1.1 Project Description .............................................................................................................................. 2 Chapter 2 : Background Information ............................................................................................................ 3 2.1 Financial Markets and Asset Classes ................................................................................................... 3 2.1.1 Types of Financial Markets .......................................................................................................... 4 2.1.2 Asset Classes ................................................................................................................................ 8 2.2 Market Behavior and Trading Strategies/Systems ........................................................................... 11 2.2.1 Set Up, Entry and Exit................................................................................................................. 15 2.2.3 Risk Management ...................................................................................................................... 16 2.2.4 Money Management ................................................................................................................. 17 2.2.5 Forex Trading Sessions ............................................................................................................... 18 2.2.6 System Overview ........................................................................................................................ 21 2.3 Fundamental Analysis ....................................................................................................................... 24 2.3.1 Economic Reports That Affect the U.S Dollar ............................................................................ 24 2.3.2 Inflation ...................................................................................................................................... 28 2.3.3 Interest Rates ............................................................................................................................. 28 2.3.4 Political Conditions..................................................................................................................... 29 2.3.5 Forex and News .......................................................................................................................... 30 2.4 The Genesis of Technical Analysis “The Dow Theory” ...................................................................... 35 2.5 Technical Analysis ............................................................................................................................. 38 2.5.1 Moving Average Indicators ........................................................................................................ 38 2.5.2 Alligator Indicator ...................................................................................................................... 42 2.5.3 Aroon Indicator .......................................................................................................................... 43 2.5.4 Relative Strength Index .............................................................................................................. 44 2.5.5 Trix (Technical analysis) ............................................................................................................. 45 iii 2.5.6 Price Channel ............................................................................................................................. 47 2.5.7 HRI .............................................................................................................................................. 48 2.5.8 The Ultimate Oscillator .............................................................................................................. 49 2.5.9 Bollinger Bands .......................................................................................................................... 51 2.5.10 MACD ....................................................................................................................................... 52 2.5.11 Momentum Indicators ............................................................................................................. 53 2.5.12 Rate-of-Change (ROC) .............................................................................................................. 54 2.5.13 Stochastic Indicators ................................................................................................................ 55 2.6 Trading Platforms .............................................................................................................................. 58 2.6.1 TradeStation vs. Metatrader ...................................................................................................... 58 Chapter 3 : Methodology ............................................................................................................................ 60 3.1 FXCM Multiple Currency Overview ................................................................................................... 60 3.1.1 Components ............................................................................................................................... 60 3.1.2 Moving Average Trading Conditions .......................................................................................... 62 3.1.3 FXCM Multiple Currency Overview External Variables .............................................................. 64 3.1.4 FXCM Dynamic PIP Overview External Variables ....................................................................... 67 3.1.5 Display Setup and Functionality ................................................................................................. 68 3.2 Three Stage Trading Strategy ............................................................................................................ 70 3.2.1 Stage One ................................................................................................................................... 70 3.2.2 Stage Two ................................................................................................................................... 71 3.2.3 Stage Three ................................................................................................................................ 71 3.3 Implementation of Trading Strategy ................................................................................................. 72 3.3.1 Implementation of the Three Stage Trading Strategy by Mariela Qirici .................................... 72 3.3.2 Individual Trading Plans ............................................................................................................. 75 Chapter 4 : Forex as a Business ................................................................................................................... 83 4.1 Types of Business Entities ................................................................................................................. 83 4.1.1 Sole proprietorship .................................................................................................................... 84 4.1.2 Business Partnership .................................................................................................................. 84 4.1.3 Limited Liability Company (LLC) ................................................................................................. 85 4.1.4 C Corporation ............................................................................................................................. 86 4.2 Tax Implications ...............................................................................................................................